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Faced with a plunging peso and increasing investor uncertainty, Argentina agreed in late September to a series of tough economic reforms in return for a $57.1 billion funding lifeline from the International Monetary Fund (IMF). As a result, the administration of President Mauricio Macri, who was elected in 2015 as an economic reformer, has secured enough liquidity to quell any uncertainty about the country’s foreign exchange liabilities through the end of his first term next year. But although the newly available financing is enough to meet those liabilities until well into 2020, in the short term, interest rates and inflation remain high, and the Central Bank of Argentina’s newly tightened monetary policy is likely to deepen the ongoing recession. Already the IMF is forecasting a contraction of 1.6 percent in 2019, which is considerably worse than official estimates placing the number at 0.5 percent.
The agreement with the IMF came in the form of renegotiations of Argentina’s existing Stand-By Agreement (SBA) forged in late June, a lending procedure that grants countries access to short-term financial assistance. Total funding has now increased to $57.1 billion, up from an original $50 billion. More important, disbursements have been moved forward, and the Argentine government will secure $13.4 billion by the end of 2018 and an extra $22.8 billion in 2019—all in all, a $19 billion increase from the original SBA.
Here’s how to interpret this arrangement: At $57.1 billion, the IMF is providing Argentina with access to resources over 1,250 percent of its quota. This is a very strong signal of support for the Argentine government, even if it stops short of a “whatever it takes” position on the part of the Fund.
In return for this assistance, Argentine authorities have committed to accelerating the process of fiscal convergence—that is, reducing the large fiscal deficit that the Macri administration inherited from its predecessor—and achieving a primary balance by end-2019, as well as a primary surplus of 1 percent in 2020. A primary surplus implies that the government’s spending should be less than its revenue, if we exclude debt interest payments from the calculation.
In order to meet these goals, the administration is moving quickly on two fronts. First, it is slashing operating expenses, subsidies, and infrastructure investment for a combined total of 1.4 percent of GDP. Second, it expects to increase revenues by approximately 1.2 percent of GDP, mainly by introducing temporary export taxes on goods and services, starting January 1.
These fiscal measures are included in the government’s proposed 2019 budget and are likely to be implemented in full. The administration has been hard at work negotiating with the provincial governors to secure support for the plan, which is being debated in Congress. The most contentious issue, export taxes, merits closer attention: These duties will eventually need to be ratified by the legislative branch. Although it is unlikely that the levies on goods will be modified in significant ways, the taxation of services exports is legally unprecedented and may prove harder to roll out.
In addition to these tough fiscal steps, the Central Bank is overhauling its monetary policy, as it switches to targeting monetary aggregates as its new nominal anchor. The goal: zero nominal growth of the monetary base until July 2019, according to Governor Guido Sandleris, who also insisted that monetary authorities’ primary goal is to rein in inflation. With the price level rising at a rate of over 40 percent this year, the amount of money in the economy will contract fiercely in real terms.
This new monetary policy has pros and cons. On the one hand, such a strong monetary contraction is likely to be effective in slowing down inflation. Because data on aggregates are available quickly, it also has the added benefit of making decision-making very transparent. Finally, it ensures no further monetization of the deficit, a feature IMF staff obviously did not overlook.
Nevertheless, the policy is also likely to deepen the recession in the short term, and it is not immediately obvious what the magnitude of this effect will be. There is a reason why monetary targets were abandoned during the 1980s: They rely on a clear and predictable relationship between money and nominal incomes—or, equivalently, on a relatively predictable money velocity. If this relationship breaks down, then the effects of a given set path for the money supply can become excessively contractionary. When one considers that money velocity tends to behave more erratically in environments of high inflation, as well as when current incomes and wealth change drastically, it becomes clear that the Argentine Central Bank will have to tread with care.
Meanwhile, the exchange rate will be allowed to float within a target zone of 33 to 44 pesos to the dollar. The bands will be raised daily at a monthly rate of 3 percent until the end of the year, when authorities will redecide the adjustment rate. The Central Bank will intervene in foreign exchange (FX) markets only if the exchange rate were to cross the predetermined bands, and, even then, only with daily interventions of up to $150 million, according to the recently introduced monetary plan.[1]
So, given this new scenario, what comes next? A cautious increase in confidence is likely. Concerns about default in the medium run should be lifted: Even in a scenario in which the country was isolated from financial markets, it has enough funds to cover all its FX needs well into 2020. More specifically, foreign currency denominated debt payments amount to $14.6 billion in 2018 and $27.2 billion in 2019, while available financing now stands at $19.4 billion and $30.3 billion (as recently calculated by fiscal analysts at Elypsis).[2]
Assuming that the currency run has passed, the most pressing challenge is when and how interest rates will go back to normal. The Central Bank raised rates to 40 percent in May and then to 60 percent in late August. In the first week of October, short-term rates for the bank’s liquidity bills reached 70 percent. Rates this high for so long are a burden on economic activity when they significantly exceed the inflation rate—but one of the consequences of the new monetary policy is that authorities can no longer set the interest rate at all. The only way for rates to return to normal is for confidence to be slowly restored. The longer it takes, the more adverse the effects on output could be.
Macri’s political endurance has been impressive so far. Throughout Latin America, approval ratings of leaders are consistently below 50 percent, often tumbling amid timid attempts at much needed reforms. Macri’s current approval rating, while low at 36 percent, is surprising given the magnitude of economic developments during the year. This durability suggests he has the political capital to continue enacting these policies, something that many prognosticators have often overlooked.
Notes
If the exchange rate goes above the top band, the Central Bank is allowed to intervene with more than $150 million, but any sales beyond that point are to be unsterilized and matched by further monetary contraction. If the exchange rate were to fall below the bottom band, the Central Bank may, as an exception stipulated in the agreement, purchase reserves and allow the monetary base to increase.
The government still faces a financing gap of $6.5 billion to service peso liabilities in 2019. Of course, local currency denominated debt cannot force a country into default.
